Credit control policy of central bank. Methods of Credit Control by Central Bank 2022-11-16
Credit control policy of central bank Rating:
A central bank's credit control policy refers to the measures it uses to regulate the amount of credit available in the economy. This is an important tool for central banks, as credit plays a significant role in economic growth and stability. By controlling the supply of credit, central banks can influence the demand for goods and services, which in turn can impact inflation and employment levels.
There are several ways in which a central bank can exert control over credit. One common method is through the use of reserve requirements, which refer to the percentage of deposits that banks must hold in reserve at the central bank. By increasing or decreasing reserve requirements, the central bank can influence the amount of credit available to banks, which in turn can impact the overall level of credit in the economy.
Another tool that central banks use is the setting of interest rates. By raising or lowering interest rates, central banks can influence the cost of borrowing money, which can impact the demand for credit. For example, if interest rates are high, consumers and businesses may be less inclined to borrow money, which can lead to a reduction in credit demand. On the other hand, if interest rates are low, there may be more demand for credit as it becomes more affordable to borrow.
In addition to these tools, central banks may also use other measures to control credit, such as moral suasion, which involves persuading banks to change their lending practices, or quantitative easing, which involves the central bank purchasing securities from banks in order to increase the supply of money in the economy.
Overall, a central bank's credit control policy plays a crucial role in maintaining economic stability and promoting growth. By using a variety of tools, central banks can help to ensure that credit is available to those who need it, while also preventing excessive credit growth that could lead to economic problems such as inflation or asset bubbles.
Monetary policy credit control measures and their effectiveness
In narrow sense—the Central Bank starts the purchase and sale of Government securities in the money market. Open Market Operations: In narrow sense, the Central Bank starts the purchase and sale of Government securities in the money market. But this is possible only when if there is a proper adjustment between the demand and supply of credit. Variable Cash Reserve Ratio: Under this system the Central Bank controls credit by changing the Cash Reserves Ratio. Thus open market operations are more effective for controlling inflation than the change in reserve ratio.
The larger the size of the excess reserves, the greater is the power of a bank to create credit, and vice versa. It is equally applicable to commercial banks and non-banking financial intermediaries. On the other hand, if it wants to expand credit, it reduces the margin requirements. This makes open market operations less effective in controlling the volume of credit. Spending would be generally reduced and including spending on imports thus solving the problem. This can be explained with the help of the deposit multiplier formula.
Mostly such circumstances are rare when the Central Bank is forced to resist to such measures. When the banks and the private individuals purchase these securities they have to make payments for these securities to the Central Bank. The real force of changes in the bank rate lies in its effects on the liquidity of the various groups of financial institutions through market interest rates which i. The bank rate is the interest rate charged by the central bank at which it provides rediscount to banks through the discount window. This condition is very essential for open market operations because without a well-developed security market the central bank will not be able to buy and sell securities on a large scale, and thereby influence the reserves of the commercial banks. As the Central Bank is only the lender of the last resort the bank rate is normally higher than the market rate.
Briefly explain the quantitative credit control policy of the central bank.
Thus, by varying the cash reserve ratio, the Central Bank can influence the creation of credit. Bank Rate Policy: The question arises whether the bank rate is more effective as an instrument of credit control or open market operations. Often small borrowers and small banks are hit harder by selective control than big borrowers and large banks. Further, some of these non-regulated lenders may be getting the funds they lent to finance the purchase of securities from commercial banks themselves. Expenditure on consumption goods is reduced. Further, since open market operations involve the sale and purchase of securities on a day-to-day and week-to-week basis, the commercial banks and the central bank which deal in them are likely to incur losses.
Then in such situation the Central Bank will start purchasing securities in the open market from Commercial Banks and private individuals. If the RBI increases the reverse repo rate, it means that the RBI is willing to offer lucrative interest rate to banks to park their money with the RBI. But the velocity of credit money is not constant. They also discriminate between different types of borrowers and banks. If the need of the economy is to expand credit, the central bank lowers the bank rate. Suppose a bicycle costs Rs. Lastly, the central bank may control the activities of commercial banks through open market operations.
How and why do central banks control the Credit policies of commercial banks? (Cam. GCE 2002)
It is, therefore, highly doubtful if they can exert any moral pressure on the banks to strictly follow the policies of the central bank. The RBI took on several developmental efforts in independent India, which was quite unusual for a central bank. Thus open market operations are superior to variable ratio because they also influence non-banking financial institutions. On the other hand, an increase in the supply of bank money through the purchase of securities will reduce the market interest rates. Quantitative Methods: The following are the quantitative methods of credit control: 1.
Depressive Effect: The variable reserve ratio has been criticised for exercising a depressive effect on the securities market. Thus it limits both the supply and demand for credit simultaneously. They place undue restrictions on the freedom of the former and affect their production. This is particularly so if the central bank does not have a large staff to check minutely the accounts of the commercial banks. Rationing of credit as an instrument of credit control was first used by the Bank of England by the end of the 18th Century. Selective Credit Controls: Selective or qualitative methods of credit control are meant to regulate and control the supply of credit among its possible users and uses. When the banks and the private individuals purchase these securities they have to make payments for these securities to the Central Bank.
Whenever banks have any shortage of funds they can borrow from the RBI, against securities. So the commercial banks will borrow more. It cannot be used for day-to-day and week-to-week adjustments but can be used to bring about large changes in the reserve positions of the commercial banks. It may also mean the minimum rate of interest at which the central bank lends to the banking system against some approved securities. Power to Control Deflation Limited: Another limitation of the bank rate policy is that the power of a central bank to force a reduction in the market rates of interest is limited. This makes the bank rate policy less effective for controlling credit in the country.
On the other hand, the central bank raises the amount of down payments and reduces the maximum periods of repayment in boom. They are different from quantitative or general methods which aim at controlling the cost and quantity of credit. Thus this instrument of credit control cannot be operative in countries which lack such a market. As the Central Bank is only the lender of the last resort the bank rate is normally higher than the market rate. As aptly put by Crowther, banks may place plenty of water before the public horse, but the horse cannot be forced to drink, if it is afraid of loss through drinking water.
Bank Rate Policy for Credit Control in Central Bank
It presupposes the existence of an educated and knowledgeable public about the monetary phenomena. But it is difficult, in practice, to select the commodities to be brought under such control or to determine the proper margin for advances. It can also be said that the larger the required reserve ratio, the lower the power of a bank to create credit, and vice versa. For example—If the Commercial Banks have excessive cash reserves on the basis of which they are creating too much of credit which is harmful for the larger interest of the economy. The central bank controls credit by making variations in the bank rate. The minimum amount of reserve with the central bank may be either a percentage of its time and demand deposits separately or of total deposits.